On Social Transfers and Income Taxation

In this paper we provide a different rationale for the use of social transfers. It is assumed that the government is unable to condition the (possibly nonlinear) income tax scheme on the productivity and the endowment of the citizens. However, people applying for social benefit have to demonstrate their financial assets, which is costly for the government to verify. We show that under weak conditions the government will prefer to provide social transfers that induce some voluntary unemployment to reduce the informational rent the highly productive and/or rich types obtain.